Who's to Blame?

Amid the mayhem in the world's financial markets, it is becoming clear that capitalism's most dangerous enemies are capitalists. No one can have watched the subprime mortgage debacle without noticing the absurd contrast between the magnitude of the failure and the lavish rewards heaped on those who presided over it. At Merrill Lynch and Citigroup, large losses on subprime securities cost chief executives their jobs—and they left with multimillion-dollar pay packages. Stanley O'Neal, the ex-head of Merrill, received an estimated $161 million.

Everyday Americans will conclude (rightly) that this brand of capitalism is rigged in favor of the privileged few. It will be said in their defense that these packages reflected years of service, often highly successful. So? It's not as if these CEOs weren't compensated in all those years. If you leave your company a shambles—with losses to be absorbed by lower-level employees, some of whom will be fired, and shareholders—do you deserve a gold-plated sendoff? Still, the more serious problem transcends the high pay itself and goes to the wider consequences for the economy.

Wall Street's pay practices perversely encourage extreme risk-taking, which can destabilize the economy. Subprime mortgage losses may simply be chapter one. Now there are signs of problems involving securities known as "credit default swaps." Never mind the details. Concentrate on the possible fallout. If banks and investment houses sustain more losses, the nation's credit system will be further wounded, and so will the economy. The Federal Reserve cut its key overnight interest rate yesterday from 4.25 percent to 3.5 percent—a huge move—in part to shore up this wobbly credit system.

By "Wall Street" I mean all the commercial banks, investment banks, mutual funds, hedge funds and the like that comprise the financial sector—but particularly investment banks. Pay is eye-popping. In 2007, Lloyd Blankfein, chief executive of Goldman Sachs, received compensation estimated at $68 million. But pay is also heavily skewed toward annual "bonuses" based on the profits that traders and bankers generate. I asked Johnson Associates, a compensation consulting firm, for typical Wall Street pay packages. The results describe "managing directors" based in New York with 10 or 15 years' experience. Most would be in their 40s.

Here are estimates for 2007:

Investment banker: $2.1 million, consisting of $275,000 in base pay plus $1.2 million in cash bonus and $625,000 in long-term bonus. (An investment banker helps firms raise capital by selling new stocks and bonds and also advises on mergers and acquisitions.)